Government must act to tackle problem of bad loans

In his foreword to the latest financial stability report, RBI governor Raghuram Rajan has rightly said that a stable government will be positive for the economy. An unstable government cannot ensure systemic improvements, needed to revive growth. Investors also need certainty in policy.

Growth remains weak despite a better outlook for India’s economy: the rupee has strengthened, current account deficit has come down to sustainable levels and India is better prepared for the tapering of the fiscal stimulus in the US. The RBI has done its bit, and now the government should act to quickly heal the economy.

It should sell excess grain to cool down retail inflation and speed up project clearances. Subsidies must be slashed as a high fiscal deficit feeds into inflation. The UPA, with its reformist credentials, must free up diesel prices fully and allow independent oil marketing.

The report says risks to the banking sector have risen in the last six months due to rising bad loans. That’s bad news, even if the current level of NPAs does not pose a systemic concern as banks are adequately capitalised. PSU banks account for the largest stressed advances. But how long can a fiscally stressed government keep pumping capital? The larger point is that a weak banking system will not be equipped to handle the needs of a growing economy.

The central bank has also warned that higher-than-normal exposure to corporates could put the entire financial system at risk as a default could spiral out of control. This, in turn, could lead to bigger losses to the system due to the interconnectedness of the banking sector. The RBI’s suggestion to tighten exposure norms for single companies and business houses, in line with global best practices, makes eminent sense. It will make the financial sector more stable.